Global markets tumble as China fear spills over

PolyaLesova

NEW YORK (MarketWatch) - Global markets tumbled on Tuesday, tracking the biggest fall on the Chinese stock market in a decade, with emerging markets taking the brunt of the hit on fears of another global sell-off.

U.S. stocks plunged to their worst one-day performance since 2001 on Tuesday, with the Dow Jones Industrial Average
DJIA, -0.05%
dropping 200 points in one minute around 3 p.m. before recovering some ground by the close. The Dow ended down 415 points, or 3.3%, at 12,216.

European equities also posted declines. The U.K.'s FTSE 100 index (UKX) lost 2.3% to 6,288.20, the German DAX Xetra 30 index (1876534) fell 2.3% at 6,867.34 and the French CAC-40 index (1804546) declined 2.6% at 5,614.4.

The declines in markets around the world were triggered by a major slump on the Chinese stock market overnight. See related story.

The Shanghai Composite Index, which tracks shares listed on the larger of China's two stock exchanges, tumbled 8.8% to 2,771.79. The decline ranks as its biggest single-day drop since the benchmark plunged 9.4% on Feb. 18, 1997, after the death of reformist Communist Party elder Deng Xiaoping. The index had hit a record on Monday. It gained a staggering 130% in 2006, making it the top performer among major global indexes.

China intervention fears

Tuesday's decline on the Chinese market was triggered by fears that the government would intervene to slow down the market.

In addition to the fall of the Shanghai Composite Index, the Shenzhen Composite, a gauge of shares on China's smaller exchange, shed 8.5% to 709.81. The benchmarks in Hong Kong, Singapore, and Malaysia also posted sharp declines. See Asia Markets.

China's "A" share market -- restricted mainly to Chinese nationals -- has run up almost 140% in the past 12 months, soaring 46% in the fourth-quarter of 2006 alone.

"The market has risen so rapidly in the last year that there's a growing sense of concern that policy makers will tighten control of the markets," said Sijin Cheng, an analyst at the Eurasia Group.

On Tuesday, the second day after the end of the Chinese New Year holiday, "concerns rose to a point where people started taking profits in anticipation of greater controls," Cheng said.

"Most of the larger-cap stocks were hit," she said. "People were taking profits left and right."

Fears of a Chinese stock market bubble reached a boiling point on Jan. 31 when a senior Chinese legislator warned that the market may be overheating. The Shanghai Composite closed down 4.9% that day.

"There is a bubble going on, investors should be concerned about the risks...But in every bull market people will invest relatively irrationally," said Cheng Siwei, vice-chairman of the standing committee of the National People's Congress, in an interview with the Financial Times in January.

Marc Chandler, a currency analyst at Brown Brothers Harriman, said that the proximate cause of Tuesday's fall on the Chinese stock market was the government's crackdown on unauthorized trading and initial public offerings.

"There is also concern that more measures both to address fears of a bubble in the stock market and the too-strong economy may emerge from the National People's Congress meeting in early March," he said.

Tightening the screws

Lan Xue, a Citigroup analyst, said that the domestic China A market was hit by a number of rumors, including one suggesting that the chairman of the China Securities Regulatory Commission (CSRC), China's securities market watchdog, is leaving his post.

"True or not, we believe this bears little relevance to the market, as the position will be held by another government official if it is true," Xue said in a Tuesday research note. "Ultimate decision power for China's stock market does not lie with the CSRC but rather levels much higher."

There was also talk of a potential rate hike, a subject of speculation since mid-January. The Central Bank of the People's Republic of China (PBOC) raised the reserve ratio last week and January inflation came in below market estimates.

"If inflationary pressure increases, the central bank should consider monetary policy action, including interest rate policy," the Xinhua Finance news service reported Zhou as saying in the interview published in the Hong Kong Commercial Daily. "The central bank must take action to curb inflation and maintain a stable yuan. This is our responsibility."

Rate move unlikely

Xue doesn't believe that a near-term interest rate hike is likely. The impact of such a hike would not be significant, because "it will not bring China back to a positive real interest rate environment," Xue said.

Traders said there was also talk the government may impose a capital gain tax, another move Xue believes is unlikely.

Such a tax "can be very damaging and we don't believe the government is ready for this," Xue said. "We believe the government has no intention of killing the market, in particular with a huge IPO pipeline."

Brandt of Emerging Portfolio Fund Research agreed: "Despite the noise, Chinese officials hope to be able to do it [tightening] in a fairly targeted manner. They have a big stake in the overall growth rate. They're most likely to err on the side of caution and avoid sweeping measures that could harm the whole economy."

Still, the sell-off sparked heavy selling in New York of exchange-traded funds based on Chinese assets.

The iShares MSCI Hong Kong Index Fund
EWH, -0.04%
which tracks the performance of the Hong Kong market, closed down 7.4% at $15.46. The iShares FTSE/Xinhua China 25 Index Fund
FXI, +0.81%
which tracks the performance of the Chinese stock market, ended down 9.9% at $95.

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